internreporter Wu Hongyuran

Before this year, Qiao said, business was booming. Customers typically started queuing at daybreak, and deal-cutting continued until the shop closed at 9 p.m. Delivery trucks for Qiao’s and other shops rolled through the trading center well into the night.

By August, however, the 20-hectare market in southeast Beijing had largely fallen silent. Most merchants closed their doors. Qiao’s shop was one of few still open for the trickle of potential buyers who surveyed products but bought few, or none.

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The scene has been repeated at steel trading centers across China, where business hit the doldrums several months ago, confirming forecasts by investment bank economists and market analysts for weaker businesses after a slowdown in 2011.

And although steel product prices have fallen sharply of late — rebar was selling for 3,500 yuan ($552) per ton in September, down from 5,000 yuan
USDCNY, +0.4041%
last year — sales are still slow and the industry’s upstream businesses, including trading companies and steel factories, are failing to pay debts.

Steel sector companies have found themselves particularly vulnerable as economic growth slows in China, because many played games with credit lines, bank loans, inventory collateralization and multi-company borrowing schemes.

Some steel manufacturers and trading firms used product inventories as collateral for bank loans, then increased their money in hand by convincing another bank to exchange the lenders’ acceptance bills for cash.

The strategy worked apparently because between 2007 and 2010, bankers too often failed to verify that acceptances were specifically tied to trading, said a Bank of China loan officer. The oversight apparently “fueled risky and speculative activities on the part of steel companies,” he said.

Some steel makers and traders, not satisfied with their own business realm, used stretched-out loans to buy speculative real estate on hopes of raising even more money, said Zhang Changhe, manager of the trader Beijing Ruisen Steel Co. Ltd.

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Trade tricks

Steel traders alone last year borrowed about 1.89 trillion yuan from banks, accounting for 3.5% of the nation’s 2011 loans in all categories, said Zhou Huarui, chairman of the Shanghai Steel Service Trade Association.

The strategy started unraveling, though, when steel prices fell and the value of collateralized steel products declined. Moreover, a real estate market cool-down since 2010 has trapped speculators including steel companies without cash needed to repay loans.

“Their money is tied up in the property market,” Wei said.

Another trick commonly employed by Shanghai steel companies, said a bank loan officer, involved defrauding banks by using the same batch of products as collateral for multiple loans. At times, several steel makers would obtain separate loans using the same inventory as collateral.

Lenders were easily duped because steel, like many commodities, is not a fixed asset that can be easily identified when used as collateral. Bankers have no way to accurately trace any particular inventory or its ownership to determine whether another borrower used it as collateral.

And bankers who tried to track down products were easily led astray by steel company executives who collaborated with warehouse companies that forged inventory documents, said a loan officer at SPD Bank.

“Loan officers are required to regularly check on stocks used as collateral,” he said. “But they may not know the real situation.”

An added layer of mischief was created by steel companies that cooperated to guarantee one another’s loans.

The practice, initially championed by banks seeking to grow their lending businesses by serving small firms, commonly involves three to five steel companies that borrow as a group. Each is responsible to help any other avert default during hard times.

Some bank executives argue that multi-company guarantees actually reduce default risk, said one banker. But even those who take the opposite position have been happy to participate.

“As long as one bank ran the business and it made money when conditions were favorable, other banks followed suit,” the banker said.

On the edge

Like many other steel company executives, Zhang faces a common predicament now that the good times for the steel sector have ended: His company can’t meet its loan obligations and might file for bankruptcy.

What’s keeping Zhang afloat, however, is that his bank is afraid that it might lose the entire unpaid portion of the loan. Bankers have told him to hang on and “repay as much as you can afford,” he said.

Plenty of borrowers, including Zhang, leveraged more than they could handle in recent years. A Shanghai-based steel company manager said industry players, who used multi-company loan networks and cashed bankers’ acceptances, could get banks to write loans worth four times the value of any collateral.

But Zhang’s banker has been far more accommodating than others in Shanghai, where the steel industry appears to have been hit harder than in other parts of the country. Banks have sued more than 30 steel manufacturers and traders in the Shanghai area this year for failing to repay loans.

Some bankers have shut the spigots: A loan officer with SPD Bank in Shanghai said his branch has stopped lending to steel companies altogether.

Beijing steel companies are a little better off than counterparts in Shanghai, despite the strain incurred through mutual loan guarantees, said Zheng Guangming, an analyst at China International Futures Co. Ltd.

In Beijing, “most companies still focus on real trading businesses and have plenty of steel in stock to back up loans,” Zheng said.

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But he said: “Steel companies in Shanghai that ran into trouble were treating steel mainly as a financing tool. This is a wrong starting point. They probably tampered with bank assessments to get loans.”

Shanghai banks also may have more exposure to steel woes, as a single, mutual loan issued between 2007 and 2010 could range between 20 million yuan and 30 million yuan, said an industry analyst. Similar borrowing deals in Beijing peaked at 6 million yuan, a senior industrial analyst said.

Some steel executives that want to stay in business are leaving Shanghai and other eastern cities for inland and western parts of the country. The best steel trading business these days can be found in Xinjiang Uygur Autonomous Region, said one company’s marketing chief.

Qiao and other Lange Baiziwan merchants, meanwhile, are clinging to hopes that business will bounce back. There’s no telling when that might be.

For now, Qiao is surviving on modest orders from small buyers, who don’t have to wait in line.

“When there is demand,” he said, “an order often comes in the form of only 50 or 100 steel pipes.”

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